On December 11, 2024, the U.S. Court of Appeals for the Fifth Circuit vacated the U.S. Securities and Exchange Commission’s (SEC’s) order approving The Nasdaq Stock Market LLC’s (Nasdaq’s) board diversity listing standards. As a result of this ruling, Nasdaq-listed companies are no longer required to disclose the board diversity information specified in the rules.1 While such disclosure is no longer mandated, companies should continue to consider possible stakeholder interest in board diversity disclosure.
Background
In August 2021, the SEC approved Nasdaq’s proposed rule change requiring new board diversity listing standards for Nasdaq-listed companies by a 3-to-2 vote. These new board diversity rules required Nasdaq-listed companies to disclose self-identified board diversity data in a standardized board diversity matrix and either 1) satisfy the applicable director diversity objective or 2) explain why they do not satisfy the applicable objective. These disclosures were required annually in the company’s proxy statement or on the company’s website. For more information on these listing standards, please see our previous Client Alert.
Shortly after the SEC’s approval, the Alliance for Fair Board Recruitment and the National Center for Public Policy Research (petitioners) filed a petition for review of the SEC’s approval, challenging the board diversity rules on constitutional grounds and contending that, the SEC exceeded its statutory authority under the Securities Exchange Act of 1934 (Exchange Act), and the SEC’s action was arbitrary and capricious in violation of the Administrative Procedure Act. On October 18, 2023, a three-judge panel of the U.S. Court of Appeals for the Fifth Circuit ruled in favor of the SEC and Nasdaq and upheld the board diversity rules. For more information on this panel decision, please see our previous Known Trends post. The petitioners then filed for a rehearing en banc (i.e., by the full Fifth Circuit) and, in February 2024, the Fifth Circuit granted the petition. The court heard oral arguments in May 2024.
The Ruling
In a 9-8 decision, the Fifth Circuit vacated the SEC’s order approving Nasdaq’s board diversity rules, holding that the “SEC failed to justify its determination that Nasdaq’s Board Diversity Proposal is consistent with the requirements of the Exchange Act.”
In its opinion, the court discussed the process by which self-regulatory organizations (SROs), like Nasdaq, may change their rules. Among other things, SROs must submit their proposed rule changes to the SEC for approval, and the SEC must approve a proposal only if it finds that the proposal is consistent with the requirements of the Exchange Act. According to the court, a proposal is consistent with the requirements of the Exchange Act if “the regulation is related to the purposes of the Exchange Act.”
In evaluating the purposes of the Exchange Act, the court reviewed and discussed the history of the law. The court explained that “Congress passed the original Exchange Act primarily to protect investors and the American economy from speculative, manipulative, and fraudulent practices[,]” and amended it in 1975 “to remove barriers to the development of a national market system.” While the court noted that “[t]here are other, ancillary purposes” for the Exchange Act, “disclosure of any and all information about listed companies is not among them.” The court then addressed each of the three purposes of the Exchange Act cited by the SEC in adopting the board diversity rules, i.e., that they were “’designed to [1] promote just and equitable principles of trade, [2] remove impediments to and perfect the mechanism of a free and open market and a national market system, and [3] protect investors and the public interest’ because it will make available information that some investors want.” The court addressed these purposes in turn and held that they “bear no relationship to the disclosure of information about the racial, gender, and sexual characteristics of directors of public companies.”
The court also discussed the major questions doctrine, finding that it confirmed the court’s conclusion. The major questions doctrine is based “on the principle that administrative agencies have no independent constitutional provenance.” Rather, they “possess only the authority that Congress has provided.” Thus, the SEC “has no inherent or implied authority, its powers to make major decisions must come only from unequivocal statutory text.” According to the court, “the major questions doctrine ‘counsels skepticism’” toward the SEC’s approval of the board diversity rules. To overcome that skepticism, the SEC had to “point to ‘clear congressional authorization’ to regulate in that manner.” The court held that the SEC failed to do so and, therefore, “failed to justify its determination that Nasdaq’s Board Diversity Proposal is consistent with the requirements of the Exchange Act.”2
What Should Companies Do Now?
With Nasdaq’s board diversity rules now vacated, Nasdaq-listed companies are no longer required to comply with them. Nasdaq has notified companies that it does not intend to appeal the decision and that companies no longer need to comply with the board diversity rules. The SEC could elect to seek review of this decision at the U.S. Supreme Court, but the incoming change in the Administration, and the anticipated policy changes at the SEC that may result, make that unlikely.
Companies should be aware that, although the Nasdaq rules no longer require disclosure, there are other stakeholders that consider board diversity information in their voting decisions, governance evaluations, and otherwise. For example, ISS Governance (see pp. 12-13 here) and Glass Lewis (see pp. 42-44 here) proxy voting guidelines both include board diversity expectations as do major asset managers such as BlackRock (see pp. 8-9 here), Fidelity (see pp. 3 here), State Street (see pp. 9-10 here), and Vanguard (see p. 6 here). Companies opting to continue to disclose board diversity information will now have more flexibility in disclosure due to the fact that they no longer are required to use the Nasdaq standardized matrix.
Additionally, while board diversity proposals have not been significant in recent years, shareholders may submit Rule 14a-8 proposals or otherwise submit correspondence to the board of directors3 requesting companies to disclose director demographics or adopt a policy to consider diverse director candidates. Therefore, companies may want to continue to consider including demographic questions in their annual director and officer questionnaires to keep the information readily available.
For more information on board diversity disclosure matters, please contact any member of the firm's public company representation practice.
[1] There are no comparable listing standards or disclosure requirements for companies listed on the New York Stock Exchange.
[2] As noted above, the petitioners also challenged the SEC’s approval on constitutional grounds; however, the court stated that it “need not reach those arguments because we resolve the case on statutory grounds.”
[3] See for example, the New York City Comptroller Board Accountability Project.
